9.4 Cumulative Translation Account Overview

Under ASC 830-30, all financial statement elements must be translated from the functional currency to the reporting currency by using a current exchange rate, which ASC 830-30-45-4 defines as “the rate as of the end of the period covered by the financial statements or as of the dates of recognition in those statements in the case of revenues, expenses, gains, and losses.” For practical reasons, ASC 830 permits the use of weighted-average exchange rates or other methods that provide a reasonable approximation of the rates in effect on the date of recognition.

The following is a summary of the exchange rates used in the translation process:

9.4.1 Recognition of Deferred Taxes for Temporary Differences Related to the CTA

As stated above, under foreign currency guidance in ASC 830, assets, liabilities, revenues, expenses, gains, and losses of a foreign subsidiary whose functional currency is the local currency are translated from that foreign currency into the reporting currency by using current exchange rates. Translation adjustments recognized as part of this process are not included in the determination of net income but are reported as a separate component of shareholders’ equity (the CTA). After a change in exchange rates, the translation process often creates basis differences in amounts equal to the parent entity’s translation adjustment because it changes the parent’s financial reporting amount of the investment in the foreign entity but the parent’s tax basis in that entity generally does not change.

A DTA or DTL may be required when an entity recognizes translation adjustments as a result of an exchange rate change if the parent entity is accruing income taxes on its outside basis difference in a particular investment (note that a CTA can be recorded on both the capital and undistributed earnings of the investment, as illustrated in the example below). However, ASC 830-30-45-21 states, in part, that if “deferred taxes are not provided for unremitted earnings of a subsidiary, in those instances, deferred taxes shall not be provided on translation adjustments.” In other words, if all or a portion of the earnings are not indefinitely reinvested and the related temporary differences will reverse within the foreseeable future (i.e., the earnings will be repatriated to the parent), translation adjustments associated with such unremitted earnings will affect the deferred taxes to be recorded. Conversely, if the earnings are indefinitely reinvested and the requirements in ASC 740-30 for not recording deferred taxes on unremitted earnings of a subsidiary have been met, deferred taxes on the translation adjustments are similarly not recorded.

Example 9-7

Assume that Entity X, a calendar-year U.S. entity whose reporting currency is USD, has a majority-owned subsidiary, S, located in the United Kingdom, and that S’s functional currency is the British pound. In addition, assume that as of December 31, 20X1, S’s net assets subject to translation under ASC 830 are 1,100 British pounds, the exchange rate between USD and the British pound is 1 to 1, X’s tax basis in S’s common stock is $1,000, and S had $100 in unremitted earnings for 20X1. Further assume that, in a manner consistent with ASC 830-10-55-10 and 55-11, the calculation of $100 in unremitted earnings was based on “an appropriately weighted average exchange rate for the period,” which was also 1 to 1.

Moreover, assume that on December 31, 20X2, S’s common stock subject to translation is unchanged at 1,000 British pounds, S’s undistributed earnings for 20X2 are 200 British pounds (the total undistributed earnings as of December 31, 20X2, are 300 British pounds), and the weighted-average exchange rate during the year between USD and the British pound remained at 1 to 1. As of December 31, 20X2, however, the exchange rate is 2 to 1. Thus, X’s investment in S is translated at $2,600, and the CTA account reflects a $1,300 pretax gain. Entity X has the intent and ability to indefinitely reinvest undistributed earnings of S (inclusive of the CTA). Thus, in accordance with ASC 740-10-25-3(a)(1), no DTL is recognized on the portion of the outside basis difference related to the undistributed earnings of S (inclusive of the CTA). Further, in accordance with ASC 830-30-45-21, no deferred taxes are provided on the translation adjustments related to the common stock.

However, if X does not have the intent and ability to indefinitely reinvest S’s earnings (although X believes that its original investment in S is considered indefinite under ASC 740-30), a DTL should be recorded for the portion of the outside basis difference related to unremitted earnings, including the $300 translation adjustment on the earnings (on the basis of a weighted average of exchange rates for the period). However, X would not have to record a DTL for the $1,000 of CTA related to the 1,000 British pounds of common stock if the initial investment is indefinitely reinvested.

Note that after the enactment date of the 2017 Act, undistributed earnings may not give rise to a taxable outside basis difference because such earnings are/were immediately includable in an entity’s U.S. taxable income (whether as a result of (1) the entity’s deemed repatriation tax (see IRC Section 965) or (2) deemed repatriation as a GILTI inclusion or Subpart F inclusion in the year earned) or are eligible for the IRC Section 245A dividends received deduction when the entity is measuring the U.S. DTL. However, there may still be a future tax impact related to foreign currency fluctuations (see IRC Section 986(c)); therefore, if X is not indefinitely reinvested in S, the $1,300 gain recognized in CTA may represent a taxable temporary difference.

When a DTL or DTA related to a parent entity’s cumulative foreign currency translation adjustments is recognized, the tax consequences of foreign currency exchange translations are generally, in accordance with the intraperiod allocation rules, reported as a component of the CTA account in accordance with ASC 740-20-45-11(b).

See Chapter 6 for a detailed discussion of intraperiod allocation.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.